Types Of Construction Contract | What Is Contract?


What Is Contract?

As per the Indian contract act 1872, A contract is defined as an agreement enforceable by law. Contract is derived from the Latin word “Contractum” which means drawn together.

A contract comes into play when there is an expression of approval of the contracting parties. The expression of approval of the contracting parties may be established proceeding with the formation of contract.

It should be remembered that an agreement without any obligation does not develop any sort of legal relationship. So, it is said that “every contract is an agreement, but every agreement is not a contract”.

Types of Contracts In Construction

A contract is a document that binds the contracting parties with some terms and conditions regarding their work and the fees to be paid for the service offered as well. In construction, a contract is an important document. There are many forms of contracts such as:

  1. Lump-sum contracts.
  2. Unit price or item rate contracts.
  3. Cost plus or percentage contracts, and
  4. Basic price contracts.

Let us see each one of them in detail below.

1. Lump-sum Contracts.

In lump-sum contracts, a contractor has to complete the work as per the given plans and specifications for a definite sum of money. The client provides all the required information regarding the project to the contractor, based on which the contractor arrives at a certain amount. Both, the client and the contractor, after a discussion and negotiation, come to an amount, which is finalized for a fixed amount of work.

This form of contract is useful when it is possible to work out the exact quantities of the items of work to be executed and also when the number of items of work is limited. For example, a sanitary block, a compound wall, a servant room a septic tank, etc.

Sometimes, some items cannot be worked under any other type of contract. So, they are given on lump-sum basis. For example, an ornamental door, demolishing an existing structure, making an opening in an existing masonry wall, making designs in plasterwork, designer grillwork, etc.

Advantages Of Lump Sum Contract

Cost Effective – The contractors work out the lump sum at their rates with a certain amount of profit. Due to the competition in the market, the contractor may quote a lower profit, eventually resulting in the low cost of work to the client or owner.

Fixed Amount – The amount to be paid to the contractor is fixed and is known to the owner since the beginning of the project. So, the owner of the project is in a position to arrange funds beforehand for the required amount to be paid to the contractor.

Early Completion Of Work – The contractor will try to finish the work as early as possible, to increase his profit.

Disadvantages Of Lump Sum Contract

Conflicting Interests – Under this form of contract, the interests of the owner as well as the contractor will be conflicting. The owner will try to take maximum advantage of work for the paid amount and the contractor will try to minimize the work to increase his profit, eventually.

If the work in a project is not fixed or is sometimes uncertain, it is difficult to work under this form of contract.

2. Unit-price or Item-rate Contract

It is a type of concrete in which a contractor quotes separate rates per unit for each item of work. The total quantity of work for each item is given by the owner, based on which the total final amount is calculated. The quantity of work stated in the contract is approximate.

The unit rate for each item of work quoted by the contractor includes materials, labours, overhead cost, and contractor’s profit, respectively. This form of contract is very flexible and so it is mostly preferred among construction professionals. Unit-rate contracts are also known as measure and value contracts or simply, measurement contracts.

Advantages Of Item-rate Contact

Flexibility – Item-rate contracts are flexible in terms of the quantity of work. The unit rate of work is fixed. So if the quantity of work is reduced or increased, the final amount is worked out accordingly and there are no conflicts regarding the work or money.

Economical – This form of contract may prove to be economical as the payment is to be done for the actual work done by the contractor.

Absence Of Uncertainties – If there are some changes in the initial plans, the contractor is not worried much about it as he is going to get a fixed rate per unit of work, actually done.

Disadvantages Of Item-rate Contract

Final Cost – As said, this is a flexible form of contract. So it is tough to predict the final quantity of the work. It can form uncertainty for the owner to arrange funds for the payment of work to the contractor.

Plan Changes – If a specific portion of work needs changes and is to be done again, it may be costly for the owners. Also, the demolishing charges apply to it.

3. Cost-plus Contract

In this form of contract, a contractor completes the work for a certain amount of fees for his services. Cost-plus contracts are very useful when the quantity and the quality of items of construction work are not known previously. Also when the market conditions are unsettled, this type of contract can be useful.

The cost-plus contracts are further divided as follows:

i) Cost-plus a Fixed Percentage

In this, a fixed percentage of the total amount is given as a fee to the contractor for his services.

ii) Cost-plus a Fixed Sum

In this arrangement, a predetermined amount, in addition to the total cost of work done by the contractors, is paid to the contractors as a fee for providing the service. Here, there is no fixed percentage, but a definite amount is decided before the commencement of work.

iii) Cost-plus a Fixed Sum With Profit Sharing Clause

This arrangement convinces the contractor to bring down the cost of work. In this, the owner gives a share in the amount saved by the contractor in addition to the fixed sum of money as agreed. The percentage of share in savings usually varies from 25 percent to 50 percent.

iv) Cost-plus a Fixed Sum With Bonus Clause

This particular arrangement is very useful when completion time is a concern. The owner fixes the date of completion of work. If the contractor can finish the work earlier than the date, he is offered a bonus, per day, for some days the work has been completed before the deadline.

v) Cost-plus a Variable Percentage

In this, the contractor is paid on a variable percentage of the actual cost of work. The amount of money saved on the actual cost of work is directly proportional to the increase of percentage in contractor’s profit. The contractor gets more amount if he can save the actual cost of work, without compromising the quality of work.

Advantages Of Cost-plus Contracts

i) The contractor is paid a fixed sum of money as profit. So he will do the work in the best interest of the owner. So, there won’t be any conflicts between the owner and the contractor.

ii) The rate of work and profit is fixed and also the quantity of work is definite. So the disputes due to extra work would be eliminated.

iii) This type of contract is useful when the work is to be done on an urgent basis.

Disadvantages Of Cost-plus Contracts

i) Sometimes the contractor may do inferior quality work in a hurry to finish the work before the deadline.

ii) When the owner is a public body, this form of the contract becomes illegal under ordinary circumstances.

4. Basic Price Contracts

A basic price contract is a modified form of the unit-rate contract. This form of contract is useful and is adopted when the market is unstable or when the rates of construction materials are fluctuating frequently.

So, the contractor mentions the rate of an item of work based on the basic price. But in the contract, it is also mentioned that if there is any change in market rates of materials, the rates shall be revised without any conflicts.

This reduces the chance of conflicts between the owner and the contractors.

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